Buy Japanese Stocks! Reaction to Livedoor-Induced Nikkei Sell-Off (EWJ, ITF, VPL, JEQ, JOF)

By now I'm sure many Seeking Alpha readers have heard about the huge news out of Japan regarding the investigation of livedoor Co. (and president Takafumi Horie) and the subsequent widespread sell-off of Japanese stocks. Sellers over the past three days of trading have sent the Nikkei 225 Stock Average (tracking ETF: EWJ) 1,113 yen lower from its 52-week high last Friday. That's a 6.8% drop in just three-days. Some analysts in Japan seem to think a 10% correction is within reason considering the impressive 40% returns experienced last year. Allow me to give you my thoughts on how to approach this sell off and the possibility that more selling will occur.

Personally, I added to my position in Japanese stocks after yesterday's sell-off via my favorite Japan investment vehicle, T. Rowe Price's Japan Fund (PRJPX). I intend to add more today given the back-to-back N225 sell offs of 460+ yen. I like PRJPX because its holdings include a number of the larger N225 stocks as well as a selection of mid- and small-cap stocks not found in iShares MSCI Japan Index (EWJ). However, EWJ being an ETF has a number of advantages over PRJPX such as lower expense fees and of course it's very liquid. Another reason why I have chosen PRJPX however, is because as editor of The Japan Stock Blog I want to keep my posts as unbiased as possible but still enjoy in the recovering Japanese economy.

That being said, I believe the best way to approach the sell off in Japan sparked by livedoor and Horiemon's investigations is to use a Warren Buffett-like mindset. By that I mean, look at the Nikkei 225 and compare the quality of the companies versus the relatively insignificant approximately US$5 billion market-cap (and rapidly dropping) livedoor. Livedoor is problematic, not the N225. This is an opportunity to capitalize on what could be called the market's irrational over-selling, especially of quality companies. The safest and easiest way to get exposure to quality and leading Japanese companies is to invest in an ETF tracking the N225 or TOPIX, such as EWJ or ITF. With these you will get exposure to approximately 225 or 150 of the top Japanese firms respectively at comparatively low expense ratios.

Understand however, that the market sentiment right now in Japan is very negative as there is a dark cloud cast over all stocks. Livedoor Co.'s president Takafumi Horie is partially to blame as he is an influential person who is closely followed but the investigation of his firm and himself does not warrant the selling we are witnessing. Indeed, Japanese stocks have seen a great rise in share price over the past year and most dramatically since mid last September when PM Koizumi won a snap election paving the way towards the privatization of Japan Post. Therefore the 6.8% correction over the past three days is not exactly as bad as it seems. The fallout from livedoor will hurt smaller-cap and start-up firms more than anything else. There is already news leaking out of Japan that there may be other firms traded on the Tokyo Stock Exchange's MOTHERS Index that are guilty of the same tactics livedoor is under investigation for.

Again, I intend to add to my position following any large drops in the N225 and will watch closely just how much more selling occurs. I would start to get concerned if the correction exceeds 10% because Japanese investors have been net sellers of stocks all along and any excessive selling would mean foreign investors are starting to take profits and cash out. A Warren Buffett-minded approach to investing is attractive because Japanese corporate earnings are expected to be strong as are leading economic indicators expected to continue to improve.

* More reading on livedoor, Horiemon, and the Nikkei's tumble:

What’s Going on in Japan? Is Horiemon’s Livedoor to Blame for the Nikkei’s 3-Day Tumble? (EWJ, ITF, VPL, JOF, JEQ, INTC, YHOO)

Livedoor’s Shares Tank 14+% as Horiemon and Livedoor Co Suffer in Stock Scheme Investigation — Open the Flood Gates (EWJ, ITF, VPL)

Livedoor’s President/CEO “Horiemon

Comments

[Internet2k4:]

The Nikkei 225 was due for correction. It's not all about Livedoor - there have been recent reports of new dilutive issues of stock in the uptrending market and concern that interest rate hikes and a stronger Yen will impact exports and therefore prices (although helping the underperforming U$ denominated ETFs.)

2006 Jan 18 04:09 PM

[Steven Towns:]

You are right, it's not all about livedoor. However, in the long run we might thank livedoor for inciting the 6.8% correction that took place the first three trading days this week. Obviously there are a number of other factors at work as you mentioned. Ultimately though the livedoor debacle might hurt the Japanese economy and stock market if the "establishment" is able to maintain its influence and old fashioned ways. Horiemon whether you like the guy or not, has been successful at shaking up the system despite his failed attempts in areas such as buying a pro baseball team, the NBS takeover, and his political bid.

2006 Jan 19 04:45 AM